A supermarket system that is neigh good

FT.com

Not since Sweeney Todd has there been such uncertainty about what exactly goes into processed meat. This time, it isn't the customers of the Demon Barber of Fleet Street but Romanian horses.
Since horsemeat is leaner than low-quality beef and contains more omega-3 fatty acids, it could be a rare case of adulteration that makes the food healthier. Still, it does not say much for the extended supply chain from which supermarkets and restaurants obtain their processed food. If they failed to notice horses, what else has trotted in?

At the top of the market, where organic butchers promote traceability, and you practically know the name of the animal you're eating, swapping a horse for a cow is unthinkable. But at the cheap end, squeezed by price spikes and growing demand for meat in China and emerging economies, strange things end up in the pot.

That can't go on. The US motor industry once dealt with suppliers in a similar fashion – squeezing them so heavily that the product deteriorated and the makers went bust. Tricky though it is to forge relationships with suppliers in a world where customers demand low prices, the food industry does not have a good alternative.

In some ways, the concentration of production and distribution in the past few decades, with corner shops being replaced by supermarkets supplied by processors, has been a good deal for the average consumer. It raised the basic level of quality – the content of British sausages and meat pies in the 1970s does not bear much thinking about – and placed a cap on prices.

The price of food in shops fell in real terms in the two decades to 2007. Not only were commodity prices low but supermarkets drove out costs by purchasing through networks of suppliers – farmers, food processors and traders – that must compete for every order.

This changed in 2007-08 with the first of several commodity price shocks. The US use of agricultural products for fuel raised the prices of corn, palm oil and rapeseed oil, and markets felt the pressure of emerging economies' growing demand for meat. China's per-capita consumption of meat has risen fourfold since 1960.

The industry was left with a long, complex, cross-border supply chain under extreme pressure. Enter the horses. In this case, Romanian horsemeat appears to have ended up in "beef” lasagne and other products in UK and French supermarkets by way of a Cypriot trader and a French distributor.

Supermarkets have thrown up their hands in horror at this, insisting they have no idea how it happened. But they were wilfully blind about their supply chains – they didn't know about the horses because they didn't know much about the cows either. They left it to first-tier suppliers, who left it to the second-tier suppliers, etc.

"Retailers don't have much information and the relationships are transactional,” says Sion Roberts, a senior partner of European Food and Farming Partnerships, a consultant. "One of their suppliers can be under severe financial pressure without them even knowing.”

Nor have they wished to know, since supermarkets – along with the life-sciences companies that produce seeds and fertilisers – have been the only ones to safeguard their margins over the past few years. The squeeze has come in the middle, among food processors and farmers.

"The farmer is a price-taker with little power in the market,” says Justin Sherrard, a global strategist at Rabobank, which believes that food suppliers need to have stronger links. "There is a limit to how far you can get by squeezing suppliers time and time again.”

The switching of horse for beef is a spectacular signal that this limit has been reached. Although few people appear to be worried about having eaten horse – nor need they be – devout Jews or Muslims have every right to be outraged at pork being muddled with beef.

Spot trading for agricultural supplies – often through e-tendering on electronic platforms – is a highly efficient way of reducing costs. But it does nothing to promote quality and improve yields, and it is difficult for suppliers and farmers to invest in the long term. They are constantly subject to price volatility while scrambling for orders.

The US motor industry was stuck in this trap before the 2008 crisis, and the bankruptcy of Chrysler and General Motors. Then, manufacturers constantly pushed suppliers to cut prices in order to lower their own costs but ended up having to sell poor-quality cars cheaply.

By contrast, Japanese manufacturers such as Toyota and Honda had a more cooperative, long-term relationship with suppliers, emphasising innovation and quality rather than rock-bottom prices. The US companies ended up having to follow their example.

It is hard to turn from a vicious cycle of cost-cutting and quality dilution to a virtuous circle of cooperation and innovation, especially when cash is scarce. Some customers will pay for traceability and direct sourcing from selected farms; for most, that is a luxury.

Yet change is possible, even for the mass market. McDonald's image was tarnished by revelations about low-quality meat processing in Eric Schlosser's Fast Food Nation in 2003. It now sources all of the beef served in its UK restaurants directly from 17,500 cattle farms in Ireland and the UK on long-term contracts. Many other food companies are adopting similar arrangements.

Given the reputational risks that supermarkets and other restaurant chains evidently face by leaving such matters to chance – or to whichever supplier volunteers an anonymous hunk of meat – that sounds like a good investment.

Copyright The Financial Times Limited 2013